﻿A quick hedge fund and market update before getting into the main topic. Hedge funds, like the mutual funds we covered in last month’s article, had a dismal year in 2014, with the Hedge Fund Index up only 3% versus 13% for the S&P 500. The industry still somehow manages to grow overall assets, even as 50% of all hedge funds have closed in the last five years; however, some prominent investors have finally taken notice. The California Public Employees’ Retirement System (CALPERS), the 2nd largest pension fund in the U.S. with $300 billion, announced last September that it plans to divest from all 30 of its hedge fund holdings. Going back to mutual funds for a moment, the New York Times published a must-read article about the awful performance of mutual funds, concluding that if fund managers “merely flipped coins – they would, as a group, probably have produced better numbers.” The stock market has been mixed so far this year with a strong February, up 5.5%, the largest monthly gain since October 2011, after a 3.1% decline in January. As of this writing the stock market has basically been flat for the year. This follows six consecutive years of gains. There have seen several articles recently stating that the “smart money” is exiting stocks with some prominent investors (e.g. Leon Black) stating that they have reduced holdings. Part of the fear is that the market is “due” for a decline. We note that in the 1980s the stock market rose eight consecutive years, and the 1990s had a nine year run. While a sharp decline may certainly arrive, it won’t occur simply because the market is due for one. The best course of action is to do nothing as over the long term investors will not be able to successfully execute two correct calls, properly timing both their exit and re-entry into the markets. An excellent article in early March in the Wall Street Journal titled “How to Survive a Bear Market” sums up our philosophy on this well. Here are the key points:

The less you tinker, the less you have the opportunity to make mistakes. People who change their holdings because they think they see a bear market coming almost always lose out.

The average investor in stock mutual funds made 4% per year over the past 30 years, far below the S&P 500. While weak mutual performance is one factor as noted above, the real reason is that people buy and sell funds at all the wrong times in attempts to time the market.

The problem with preparing for a bear market: people aren't good at picking the top, and they panic once stocks have fallen heavily.

Even people who do get out before a bear market often shoot themselves in the foot: They are too frightened to get back in and miss the rebound.

The best question to ask is not “where is the market headed?” but “when do I need the money?” Money needed later on has time to recover from a decline, so can be invested in assets like stocks.

For people who like to trade: take 10% of your money and play with it.

On to the next topic. There has been a recent push by the Obama administration to require all financial advisers to adhere to a “fiduciary standard,” which would mean advisers would have to always act in their client’s best interest. It seems like this should be obvious, but remarkably, most financial advisers and stockbrokers today are not held to this standard; instead, they can recommend and sell any investment, even if more expensive or not the best fit for the client, as long as it meets a much weaker “suitability” standard. As Obama put it a few weeks ago in a speech supporting this initiative: “Outdated regulations, legal loopholes, fine print, all that stuff today makes it harder for savers to know who they can trust.” All Registered Investment Advisors, like Downtown Investment Advisory, are already required to adhere to the more meaningful fiduciary standard. Unfortunately for customers, RIA’s comprise only a small portion of the investment advisory business, which is dominated by the larger firms. Not surprisingly, these large firms are heavily lobbying against the fiduciary standard to the outrage of a wide range of consumer protection groups and other organizations like the AARP. One of the groups opposing this sensible rule, the Securities Industry and Financial Markets Association (SIFMA), argues that a fiduciary standard would limit the public’s access to investment advice – an argument which we do not understand. The real reason for the opposition of course is that the rule would lead to much lower industry fees. We doubt that the rule will be passed as the industry and its backers are powerful.﻿

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